In Alberta, a couple we’ll call Julius, 60, and Emma, 58, are edging into retirement in the first quarter of 2011. A former financial-services executive, Julius has a non-indexed base pension of $6,650 a month. Their prospective pre-tax base income as soon as they are fully retired will be $10,258 a month, composed of Julius’s non-indexed pension and two CPP early benefits of an estimated $654 each and Emma’s company pension of $2,300 a month, all in 2011 dollars. Income from their $400,000 in RRSPs and $70,200 in other investments will be available, if they wish to draw it. Their anticipated retirement cash flow will be a good deal less than what they had when Julius was grossing $275,000 and Emma $87,000 a year prior to retirement.

The Issues

Their problem will be to adjust to living on a lower but adequate income. That will take a reduction in expectations. “It might be difficult to make the transition from employment to retirement,” Julius says. “Having retired relatively young, we have decades of exposure to inflation. What should we do to protect ourselves?”

Family Finance asked Don Forbes, head of Don Forbes & Associates/Armstrong & Quaile in Carberry, Man., to work with Julius and Emma.

“There are several important issues in the retirement that the couple is planning,” Mr. Forbes explains. “Inflation is a threat, but the more they raise their returns on invested capital and their incomes, the better-protected they will be. Likewise, the more they can save on taxes, the more money they will have left to maintain their purchasing power no matter what happens with inflation. For now, it would seem that they have a buffer in substantial monthly savings.”

The Five Year Plan

Year 1(2011) Julius should begin to draw Canada Pension Plan benefits as soon as possible. Emma, who will be 60 in two years, should also apply for early benefits, Mr. Forbes advises. The reason? Reduced tax rates. Early application for benefits reduces CPP payments by 0.5% a month for each month prior to age 65 at which benefits begin. But starting in 2012, the reduction will be 0.6% for each month before age 65 that benefits start. Not only is there a relative gain to be had in taking the money sooner rather than later, but if one applies a reasonable rate of return, say 6% a year, to the early benefits which Julius can include in monthly savings, enhanced returns will compensate for the penalty, the planner notes. Tax on the 6% return could reduce the net return, but if the money is invested in assets that produce Canadian-source dividends or capital gains, the bite would be modest.

Year 2(2012) Julius and Emma will have a growing surplus of income over spending. The problem is what to do with it. Current financial security is not an issue, but what happens in the future is an open question. They may consider long-term care insurance as a way of protecting their estate from potential medical or related expenses in old age. Premiums can be quite high, but some policies have a refund-of-premiums option built in if no claims are made. The effect of having this insurance is to cut into available funds for spending now in exchange for what could be more money later. Its real benefit would be for their two adult children and three grandchildren. They should shop the idea among independent insurance agents.

Year 3(2013) The North American economic recovery should be well underway, boosting inflation rates. Inflation will reduce the couple’s real RRSP income. Currently, their RRSPs are invested in a chartered bank’s balanced funds. The management fees for the funds are about 2%, which is below the 2.4% average management fees for Canadian equity funds but far above the 1.5% average for bond funds. Even so, the couple would do better to switch to the bank’s lower-fee index funds. They could cut costs further by switching to exchange-traded funds with fees of about 0.20% to 0.60% a year. They could also buy low-fee bond ladders that replicate Canadian government bonds and Canadian corporate bonds. Cutting management fees would leave the couple with more money to protect them from inflation, Mr. Forbes suggests.

Year 4(2014) Julius is now 64. It is time for the couple to reduce their exposure from stocks in favour of more bonds, which, if the recovery continues, should bear higher interest rates than they did in 2010. Bonds have the special quality, unmatched by stocks, of returning their principal to the holder (or fund) at maturity. Moreover, much of the damage that rising rates do to existing bonds that lose appeal in the face of higher interest paid by new bonds should be priced into existing bonds, reducing though not eliminating downside price risk. The usual strategy is to match the investor’s age with bond level. That implies about 60% to 65% bonds in the couple’s RRSPs. However, with the substantial pension income the couple enjoys, they could cut bonds to 45% and still have adequate security.

Year 5(2015) Julius is now 65. If he has not already made use of the pension income credit of 15% of qualifying pension income up to $2,000 of pension income, he should do so. Qualifying income does not include the Canada Pension Plan, Old Age Security or, for that matter, Guaranteed Income Supplement payments. But private pension income from company pension plans, annuity income, RRSP distributions and deferred profit-sharing plan distributions qualify.

The Longer View

By 2024, when Julius is 74 and Emma is 72, the couple will have what Mr. Forbes estimates will be combined income of $150,736 in future dollars consisting of two Old Age Security benefits of $7,710 each, combined CPP benefits of $16,116, combined annual pension income of $113,200 and RRIF withdrawals of $6,000 a year, all in future dollars. Assuming income splitting that will make each partner’s income $75,368, they will escape almost all the Old Age Security clawback, which currently begins at $67,668 and which will rise with indexation by an estimated 1.5% a year to about $75,300 in 2024 when each partner is at least age 72 and receiving RRIF income.

Julius and Emma have toyed with the idea of buying a vacation home or even of moving up to a grander house than the one they now have. They need to ask themselves how choicer digs relate to their plan to create a legacy for their children and grandchildren. If the house forms part of their estate and if it appreciates, they could have both home and bequest. However, they would have to borrow to buy the property, for their total non-registered assets are only $50,000. They would be saddled with a hefty debt subject to rising interest rates in future. Best bet — forget the new manse and stay out of debt, Mr. Forbes suggests.

“The older you get, the more important it is to reduce portfolio risk,” Mr. Forbes says. “The problem of portfolio management and estate planning late in life is not so much making money, but keeping it.”

Almost Done!

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By clicking "Create Account", I hearby grant permission to Postmedia to use my account information to create my account.

I also accept and agree to be bound by Postmedia's Terms and Conditions with respect to my use of the Site and I have read and understand Postmedia's Privacy Statement. I consent to the collection, use, maintenance, and disclosure of my information in accordance with the Postmedia's Privacy Policy.